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A contractor’s introduction to Director’s Loans

There may be a time when you need to loan money to or borrow money from your own Limited Company. Director’s loans are wrapped up in fiddly bits of legislation. When borrowing cash from your company, care must be taken. You must ensure that you fully understand the tax implications before you take any kind of loan from your business.

In this guide, we’ll explain what a director’s loan is, the guidelines to abide by, and the tax implications so you can ensure you remain compliant and avoid any surprise tax bills.

Borrowing money from your Limited Company

An introduction to director’s loans

HMRC defines a director’s loan as:

A director’s loan is when you (or other close family members) get money from your company that is not:
  • a salary, dividend or expense repayment
  • money you’ve previously paid into or loaned the company

Matt Poyser from inniAccountsBy Matt Poyser, who now writes for Listentotaxman.com on matters relating to contracting and limited company taxes.

Matt is a previous contractor with a wealth of experience and the Director of Client Experience at inniAccounts (an accountancy service tailored for contractors, consultants and freelancers).

Have a question? inniAccounts are happy to help Listentotaxman visitors with any queries,
simply contact them here.

There are many reasons why you may need to take a loan from your company, such as to finance the purchase of a house or to fund a sudden unexpected expense.

It’s important to remember that your Limited Company is a separate entity with its own responsibilities and legal obligations. The funds in your business bank account do not belong to you. As a director, you can take money out of the company. But, any money taken from the bank account that does not relate to a salary, dividend or expense repayment is classified as a director’s loan.

Withdrawing a director’s loan

You can simply withdraw your director’s loan from the business bank account without declaring it as a dividend or paying it as a salary.

It’s worth noting that some contractors may unwittingly end up with a director’s loan in this way if they try to distribute a dividend when there are not enough profits in the business to declare one.

Recording director’s loans

It’s vitally important that you keep a record of any funds you borrow from your company. This record is known as a director’s loan account. Your director’s loan account should record; any cash withdrawals from the company that you’ve made as a director and any personal expenses which were paid with company money. You can find more information on business expenses over at Inni Accounts. Your director’s loan account must contain evidence of all transactions involving both your personal and company’s finances to stand up to scrutiny. HMRC will review your director’s loan account, through your company’s annual tax returns, to ensure its guidelines are being followed.

Tax implications

Directors can take out tax-free loans from their company for a specified period. However, there are some important rules to consider on these loans. One is the length of time you can borrow the money without being taxed on the amount borrowed, the other is the amount you can borrow as a director before it’s considered a benefit in kind.

The length of time you can borrow

HMRC have strict rules on director’s loans. Before the loan is issued, it’s important to note that the loan must be repaid within nine months and one day of your company’s year-end. If you fail to repay the loan amount by the deadline, you will face tax implications. Any outstanding loan amount that is not repaid is subject to a supplementary Corporation Tax charge, known as S455 tax, at a rate of 32.5% payable to HMRC.

As an example, if you took a loan of £5,000 on 2nd March 2018, and this was still outstanding at the company’s year end of 31st March 2018, you will need to pay HMRC £1,625 in additional Corporation Tax if the loan is not repaid by 31st December 2018.

Once the loan is repaid the Corporation Tax on the loan amount can be reclaimed, however, this can’t be done until nine months after the end of the accounting period in which the loan was paid off and getting your refund can be a very lengthy process. If you choose to withdraw a director’s loan from your Limited Company, it’s best to ensure you can repay it within HMRC’s timeframe.

While we recommend your accounts and Corporation Tax returns are filed as soon as possible after your company financial year end, the Corporation Tax payment deadline is 9 months after this. This would allow you additional time to repay the loan therefore avoiding the additional Corporation Tax.

The amount you can borrow

There is no limit to the amount that can be taken as a director’s loan. However, if your loan account does become overdrawn by £10,000, it means you will have received a benefit in kind. Benefits in kind are any personal benefits received from your company, such as interest free loan, that are taxable. They must be declared to HMRC using a form known as a P11D and as a result additional income tax may be due plus your company may have to pay Class 1A National Insurance at 13.8% on the full value of the benefits.

Should you need a loan, best practice is to keep it below £10,000 to avoid additional tax and National Insurance and if possible, repay the loan in full before the end of your company financial year.

Repaying a director’s loan

To repay your director’s loan, simply transfer the money back into the company bank account or allocate a salary or dividend payment against the loan to reduce the balance.

It’s recommended that you do not take out a director’s loan immediately after repaying one. HMRC judge this as a tax avoidance tactic known as ‘bed and breakfasting’. This is a method that directors sometimes use to avoid tax; by repaying their loan before the company year end to avoid penalties, only to take it out again immediately without any real intention of ever repaying the loan. In addition to repaying the loan you need to ensure that there is a gap of at least 30 days before you take another loan from the company.

Clearing a director’s loan

Most directors who take out a loan have sincere intentions. However, circumstances such as a failure to find a contract, sudden termination of a project or a personal emergency can impede company profits and leave the director unable to repay. Your company can write off a director’s loan, but there are tax implications that must be considered and the loan must be formally waived.

A company can clear or release a director’s loan by distributing a dividend if there are reserves available. For income tax purposes, the amount is treated as a dividend with the usual tax liabilities and will need to be included on the director’s self-assessment tax return. Class 1A National Insurance will also be payable by the company on the amount of the loan written off.

Loaning money to your Limited Company

Loaning money to your company is an easier process than borrowing. When you start a business especially, there are initial costs such as insurance premiums, website packages, stationary and accountancy fees. To keep everything tidy from the outset it’s a good idea to loan your business some money whilst you’re waiting for payment from your first customer. As with borrowing funds, you need to ensure you keep scrupulous records of the funds involved.

Your company won’t pay any Corporation Tax on the money you lend it. You can also withdraw the full amount as and when cashflow in the company allows. If you choose to charge any interest, this will be classified as a business expense for your company and personal income for you. The interest income will need to be declared on your self-assessment and will be taxed accordingly. You can find more details on interest rates here. A CT61 form will also need to be completed.

Next steps

Director’s loans can get very complicated, very quickly. Due to the tax implications it’s wise to only withdraw one if you really need it. Our advice, is to always to talk to an accountant to understand the consequences of a director’s loan. The best way to ensure you’re making an informed and compliant decision is to seek the advice of a specialist contractor accountant who can get to know your personal circumstances.

Matt Poyser from inniAccountsBy Matt Poyser, who now writes for Listentotaxman.com on matters relating to contracting and limited company taxes.

Matt is a previous contractor with a wealth of experience and the Director of Client Experience at inniAccounts (an accountancy service tailored for contractors, consultants and freelancers).

Have a question? inniAccounts are happy to help Listentotaxman visitors with any queries, simply contact them here.

This article was published in our Guides section on 09/01/2019.

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